Traditional IRA Converted to Roth IRA – Watch Your Step

October 17th, 2017 No comments

A taxpayer recently informed us that he did a Roth conversion. After completing the conversion, he asked if the IRS could “undo” the conversion under the “step transaction” doctrine. As a side note, it is ALWAYS best to consult with your tax advisor before rather than after making a financial transaction.

The Roth Conversion: In its simplest form, a Roth conversion is when a taxpayer converts a traditional IRA to a Roth IRA. This is allowed by the Internal Revenue Code. When the conversion is made, the taxpayer incurs an income tax liability related to the untaxed earnings that have accumulated in the traditional IRA. Why would someone want to pre-pay their income taxes? Based on several factors which will not be discussed herein, it may be a sound financial decision to pay taxes today to avoid the future taxes that will be due when RMDs (required minimum distributions) are required to be made at age 70 ½ and there are also wealth transfer considerations. Remember that Roth IRAs do not have RMDs and the monies in a Roth account can be withdrawn tax-free once certain conditions are satisfied.

The taxpayer who asked the question was doing what is referred to as a “backdoor” Roth conversion. In this situation, the taxpayer is not eligible to make a Roth IRA contribution. The taxpayer then makes a non-deductible traditional IRA contribution and then (almost immediately) converts that IRA to a Roth IRA. Since the non-deductible traditional IRA likely has little or no earnings, there is little or no income tax due on the Roth conversion.

The Step Transaction Doctrine: This is a judicial doctrine that combines a series of formally separate steps, resulting in tax treatment as a single integrated event. This doctrine is often used in combination with other doctrines, such as substance over form. Thus, the taxpayer who is ineligible to make a Roth contribution as a single transaction is precluded from making the contribution by entering into a multiple of other steps to obtain the desired result. In other words, the multiple steps are collapsed into a single step.

Old and Cold: This is an unstated rule that is generally known to experienced tax practitioners. At some point, events are so old and cold that they acquire reality by themselves and cease to be part of an overall plan or transaction. How long this takes is unclear. Some practitioners would likely argue that a transaction has to be at least two tax years old. We have seen some taxpayers delay a transaction for one full year and a day in another tax year. For example, if a traditional IRA contribution is made in 2017 and the conversion occurs on January 2 in 2019, have two tax years passed? The taxpayer would argue that the step transaction and substance over form doctrines would not apply because the first step of the event occurred in the second preceding tax year.

However, the above old and cold argument is less likely to prevail if the taxpayer consistently each year converted his/her traditional IRA to a Roth IRA.

If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.

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Revocable Trust vs. Irrevocable Trust

October 10th, 2017 No comments

Financial planning includes periodically meeting with an experienced estate tax attorney to ensure that one’s estate plan is current and meets the objectives of the individual. When meeting with legal counsel, one would be well served by understanding the differences between a revocable trust and an irrevocable trust. All comments here are personal and should not be considered the rendering of legal advice. We are not attorneys. Only attorneys can render legal advice which is why we recommend that you seek competent legal advice on these matters.

In its most simplistic terms, a revocable trust (RT) is where the grantor of the trust (you) continue to own the assets in the trust. The trust is reported under your social security number and all income of the trust is reported by you. RTs are often referred to as “grantor trusts” or “living trusts” and are essentially just an extension of your will.

A RT differs from an irrevocable trust (IT) where the ownership of the assets is transferred Read more…


Are You Are Being “Liked” by the IRS

October 3rd, 2017 No comments

Eric Sorensen of WSU News has reported that “The next time you want to tweet something about how much you hate paying taxes, or what you did with your huge tax refund, you might want to rethink it.” Mr. Sorensen referenced the work of Kimberly Houser, a clinical assistant professor of business law at Washington State University’s Carson College of Business, that the IRS is breaking several laws by mining large data sets and combing through social media posts (like Facebook, Instagram and Twitter) in its search for taxpayers to audit.

Mr. Sorensen reported that “According to information obtained by the American Civil Liberties Union, the IRS also has violated Read more…


The Cost of Borrowing from Your 401(k) Plan

September 26th, 2017 No comments

If your employer has a 401(k) plan, the plan likely has a provision that allows you to borrow from the plan. Although the plan will charge you interest on the amount borrowed, the repayment of the interest and amount borrowed go back into your 401(k) plan. So regardless of the rate of interest charged, whether it is 3% or 5%, isn’t your net cost of borrowing zero because you are paying yourself? Doesn’t it sound like an interest-free loan?

If it were truly an interest-free loan, would it not make sense to borrow as much as possible from your 401(k) plan? After all, if the plan charges a 5% interest rate, where in today’s market can you earn 5% guaranteed? Should you borrow the max from your 401(k) plan to maximize your financial wealth?

The misconception about these plans is that Read more…


Will Tax Returns Require a Selfie?

September 19th, 2017 No comments

Tax jurisdictions are prime targets for hackers and scammers. Identify theft of a person’s social security number, date of birth, W-2 information, and other data allow thieves to file false tax returns and claim false refund claims.

What are states doing to combat ID theft? The first line of defense is that states are delaying the issuance of refunds to allow them more time to verify that the tax returns filed are actually those of the taxpayer and not those of a thief. Taxpayers’ situations are not static and can change significantly during the tax year (e.g., new job paying a higher salary, additional dependent, marital status change, etc.) Accordingly, working with your tax professional during the tax year to ensure that significant overpayments are not made is more important today than ever.

Four states (AL, IL, OH, NY) require that taxpayers who e-file their returns provide their driver license information. Some states allow taxpayers to provide this information on a voluntary basis. It has been rumored Read more…


Filing an Extension of Time to File Form 1040 – The Good, the Bad and the Ugly

September 12th, 2017 No comments

There are many taxpayers who experience great angst to learn that their return cannot be filed by the due date of April 15 and need to file for an extension of time to file until October 15. There are other taxpayers, for whatever reason, the filing of an extension is a regular, annual occurrence.

First, we need to discuss a few truisms: Read more…


Will Colleges & Universities Finally Be Required to Properly Complete Form 1098-T

September 5th, 2017 No comments

The 2015 Protecting Americans from Tax Hikes Act (Act) required that colleges and universities (colleges) report the actual amount paid by students (or their parents) for qualified tuition expenses. What the colleges have been reporting is the amount billed for qualified tuition expenses. Amounts paid are shown in box 1 of Form 1098-T; amounts billed are shown in box 2.

Due to the above practice by colleges and IRS due diligence requirements imposed by the IRS on those preparing tax returns claiming the American Opportunity Tax Credit, tax preparers needed to request that taxpayers provide them with cancelled checks, bursar statements showing the amounts paid, or other forms of proof of payment to properly compute the educational credits. Thus the current practice by colleges placed a burden upon those claiming tuition credits and upon tax preparers.

It has been reported Read more…


Consider Your Options When Leaving House to Heirs

August 29th, 2017 No comments

For many individuals, their personal residence is likely their most valuable asset. If you wish to leave your residence to a specific person when you die, you need to include the passage of your home in your estate plan to ensure that your wishes become reality.

While this blog posting will discuss some of the options available to you, it is not all-comprehensive and you need to discuss your wishes with your estate attorney (and perhaps a real estate attorney). Due to the tax laws regarding basis in your personal residence and how to compute the taxable gain when a home is sold or transferred, it is best to include your tax professional in these estate planning meetings to avoid unpleasant tax surprises.

Here are some options available to you. Read more…


Charitable Contributions Lack Goodwill

August 22nd, 2017 No comments

The IRS strictly enforces its requirements to claim charitable contributions. And yet, taxpayers continue to ignore these rules and find themselves being audited by the IRS. Often, not only do these taxpayers get assessed additional taxes for non-conformance of the tax rules, but are assessed penalties for their follies.

Let’s look at the case of Mark and Rose Ohde (T.C. Memo. 2017-137). When reading the facts of this case, not only is it difficult to believe that the taxpayers actually claimed these deductions, but that they went to Tax Court to appeal the IRS’s assessment.

The taxpayers argued before the Tax Court that they were entitled to a 2011 tax year noncash charitable contribution deduction of $145,250 for the more than 20,000 items of property they made to Goodwill. While residents of West Virginia, the taxpayers claim they drove to a Goodwill location in Maryland. Doing a search on the Internet for Goodwill store locations in West Virginia, 30 sites were found. How many rational persons would drive to another state to make a donation to Goodwill?

As a sampling, their 2011 claimed donations included 1,040 items of boy’s clothing, 811 items of girl’s clothing, 685 items of men’s clothing, 945 items of women’s clothing, 115 chairs, 36 lamps, 22 bookshelves, 20 desks, 20 chest of drawers, 16 bed frames, and 14 filing cabinets. Taxpayers provided for each delivery to Goodwill a one-page printed receipt that showed that Goodwill had received items in one or more of the following categories: clothing, shoes, media, furniture, and household items. There was no detail showing the number of items received or a description of the items received.

At trial, it was demonstrated that the taxpayer did not maintain a contemporaneous log showing the items contributed. Instead, the taxpayer used a TurboTax program called “Its Deductible”. For each item category entered into this program, the taxpayer showed the quantity as being “high”. The total dollar values in this program for each trip ranged from a low of $830 to a high of $14,999. However, not a single contributed item was reflected as a dollar value and the cost of the items donated was not shown. Only the grand totals were shown in this program.

If you think that the taxpayer’s were somewhat aggressive in 2011, consider the fact that for the years 2007-2010 Read more…


Surprise – Why You Can’t Deduct Your S Corp Losses?

August 15th, 2017 No comments

Your business had a very challenging year. It incurred significant losses but you seemingly have the solace in knowing that you can offset your W-2 earnings and interest and dividend income with those losses. But then you receive unexpected news from your tax professional – you are unable to deduct your S Corp. losses because you lack basis.

What is “basis”? In a nutshell, a shareholder may not deduct expenses of an S corporation Read more…

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